Now You See Them, Now You Don’t: the Case of the Shrinking Global Economic Imbalances

Global economic imbalances in the mid-2000s reached a level that many commentators viewed as unsustainable. The claim was frequently made that the imbalances contributed significantly to causing the world-wide financial and economic crisis at the end of the decade. Since the mid-2000s the imbalances have shrunk considerably, and their pattern has also changed. This article uses conventional balance of payments theories to examine what may have been happening. It draws on empirical evidence to assess which theories receive the strongest support from the available data. It emerges that most of the adjustment has been brought about by reductions in expenditure in deficit countries. With some notable exceptions, expenditure switching by means of changes in real effective exchange rates has generally made only an extremely modest contribution. The article goes on to contemplate the future evolution of imbalances. The experience with global economic imbalances since the world economic crisis raises many fundamental issues about the future design of the international monetary system. These include the type of adjustment and financing mechanisms embodied in it, as well as the nature of international macroeconomic policy co-ordination.